Capital Structure

 Long term
 Loan - Interest
 Debentures- Interest
 Equity Share – Dividend (Rs 10) Rs 2 = Rs 8
 Preference shares capital – Fixed dividend
 Retained earnings –div

Capital  Sales-VC-FC= EBDIT- Dep= EBIT- Interest = EBT

 Short term
Structure  Short term Loans

+ 

LOC
Commercial paper
Cost of Capital 

Trade credit
Advances
 Public deposit
 Factoring
 Bill of discount
 Overdraft
 CC
  Credit rating of the company
 Debt to equity ratio/ value of the company
 Inflation/ risk free rate
 Competition
 Past profit ratio
 Riskiness of project-PHF –SME-DHFL
 Market opportunities – sales-Profit
 Sufficient cash in the market
Cost of capital  Investment policy/ stock market condition
 Dividend policy
 Nature of business
 Solvency of company
 Govt taxation policies
 Govt policies
 Economic condition
 Duration
 Purpose
  Long term
 Bonds/ Debt - Interest
 Equity shares- Dividend
 Preference shares – Fixed dividend + div tax
 Loan- Interest
 Retained earnings- Div
Capital  EBDIT-Interest= EBT

structure / cost  Short term – working capital

 Commercial paper
of capital (Ko)  Trade credit

Div A 

Bill discounting / bill of exchange
Overdraft
 Letter of credit
 Public deposit- s, m, l
 Short term loan
 Factoring
 Cash credit
Factor affect
cost of capital
+ cost of
debt/cost of pr
  Credit rating
 Purpose of raising capital
 Govt policies
 Brokerage cost/commission
 Inflation
 Economic condition of the country
 Corporate tax

Factors  Risk free rate/ RBI policy

 Dividend policy
affecting cost  Debt to Equity ratio- 4:1 / 1:1
of capital  Riskiness of the project
 Financial soundness
 Growth / stage of company – sources – cost /
 Country risk
 Duration
 Exchange rate – ADR/GDR –Infosys – Dividend INR-$ (INR Dep)
 Investment policy
 Stock market condition
  Long term
 Debentures- Interest (2016-IR high)
 Equity- Dividend
 Equity- ADR/GDR
Capital Re-  Loans- Interest

structure Preferences shares- Fixed dividend+ tax
 Short term
 Cost of capital – WACC
 Leverage
  Debentures- Interest
 Loans- Interest
Capital  Equity – Dividend

Structure  Preference shares- Fixed Dividend

 Cost of capital using WACC-10% 9%

  Financing Decision
 Where?
 Capital Structure
 Cost of capital
Learning  Leverage
 Investment Decision
 Capital Budgeting
  Long term-
 Debt/bond/debentures- Interest
 Retained earning
 Loan- Interest
 Equity- Dividend
 Preference shares- Fixed dividend

Sources of  Short term- working capital

 Trade credit
finance- Cost 

Commercial bank loan
Advances
 Public deposit
 Deferred income
 Bill of exchange
 ICD
 Bank overdraft
 Commercial papers
 Factoring
  Duration
 Capital provider preferences
 Inflation
 Amount of capital/size of issue
 Foreign trade deficit –
 Tax benefit
Factor  Credit rating of the company

affecting cost  Govt policies

 GDP/ Economy
of capital  RBI policy
 Risk free rate
 Tax shield
 Interest coverage ratio
 Exchange rate
 Debt equity ratio
 Dividend policy
 • The capital structure is the particular combination
of debt and equity used by a company to finance its overall
operations and growth.
• Capital structure is how a company funds its overall operations
and growth.
• Equity capital arises from ownership shares in a company and
claims to its future cash flows and profits. Equity consists of
Capital ownership rights in the company, without the need to pay back
any investment.
Structure • Debt comes in the form of bond issues or loans, while equity may
come in the form of common stock, preferred stock, or retained
earnings.
• Debt consists of borrowed money that is due back to the lender,
commonly with interest expense.
• Short-term debt is also considered to be part of the capital
structure.
• The Debt-to-Equity (D/E) ratio is useful in determining the
riskiness of a company's borrowing practices.
  Capital structure can be a mixture of a company's long-term debt,
short-term debt, common stock, and preferred stock. A
company's proportion of short-term debt versus long-term debt is
considered when analyzing its capital structure.
 When analysts refer to capital structure, they are most likely
Capital Re- referring to a firm's debt-to-equity (D/E) ratio, which provides
insight into how risky a company's borrowing practices are.
Structure  Usually, a company that is heavily financed by debt has a more
aggressive capital structure and therefore poses a greater risk to
investors. This risk, however, may be the primary source of the
firm's growth.
  Public deposit-25% of share capital
 Deferred income
 Commercial paper 15 days- 364 days
 Factoring- Company appoints ‘Factor’
 Bill of exchange

Short term  Trade credit

 Overdraft
sources  Letter of Credit
 Accrued Expenses
 Instalments
 Working capital loans
 Money lender
  Capital structure decision refers to the proportion of debt and
equity and finding out whether there is a capital structure that can
be said to be optimum for the shareholders of the firm.
 Put it simply, can the value of the firm be enhanced by changing
the mix of debt and equity?
Introduction  A mix of a company's long-term debt, specific short-term debt,
common equity and preferred equity. The capital structure is how a
firm finances its overall operations and growth by using different
sources of funds.
  To analyze the effect of capital structure, one form of capital
must needs to be replaced with another
Common  Maximization of value of the firm is consistent with
assumptions maximization of shareholder’s wealth
for Analysis  Optimum capital structure is one that minimizes WACC
 Constancy of earning level
  The capital structure of a company/firm plays a very important role in
Capital determining the value of a firm
 Capital structure is also referred to as financial leverage, which strictly
Structure means the proportion of debt or borrowed funds in the financing mix of a
Theory company
 Debt structuring can be a handy option because the interest payable on
debts is tax deductible But increasing debt has its own share of drawbacks
  Business Risk -Demand, Selling Price, Cost

Factors affecting  Financial Flexibility or Financial Risk -debt providers don’t bear any
capital-structure business risk
decision  Management Style

 Growth Rate

 Market Conditions
 Debt Free companies
 https://indiancompanies.in/list-of-zero-debt-companies-in-india-2
021/
 https://www.goodreturns.in/personal-finance/planning/best-10-de
bit-free-company-stocks-to-invest-in-india-2021-how-to-find-deb
t-free-companies/articlecontent-pf20311-1212503.html
Leveraged
firm- Weighted  https://www.businesstoday.in/bt-newsflicks/photo/indian-
down by companies-highest-debt-248549-2020-03-02-1

leverage
Cost of Capital
  Trade credit
 Letter of credit
 Cash credit
 Short term loan
 Commercial paper /CD
 Bank guarantee
Short term  Deferred revenues

source  Advances- Accrued expenses

 Factoring
 Bill of exchange /Bill discount
 Public deposit
  Amt of capital company wants to raise
 Financial position- Previous- Credit rating BB--
 Tax structure
 Interest rate- Risk free rate
 Inflation
 Policy of company
Factor – cost of  Current debt equity ratio

capital  Duration
 Business risk
 Competition
 Govt policies
 Market condition
 Currency value – INFY ADR- Dividend -$ INR dep- increase cost
 Investment plan- Bond – repay –higher %
  To calculate the cost of capital for different sources:-
 Cost of Equity
 Cost of Preference capital
 Cost of Debt

Objectives  Cost of Retained Earnings

 To understand different methods of calculating the cost of equity
capital
 To compute the WACC (weighted average cost of capital for the
firm
  Cost of capital of a firm refers to the cost that a firm incurs in
retaining the funds obtained from various sources ( ie equity
shares, preference shares, Debt, retained earnings)
 It is the minimum rate of return the firm must earn on its
Cost of Capital investments in order to satisfy the expectations of investors
who provide the funds to the firm.
 Business should at least be capable of earning so much
revenue as to be able to meet its cost of capital.
 Debt-
Equity Mix

Factors Cost of Market

affecting cost Financial
Interest

capital
soundness
Rate
of capital

Riskiness
of Project
  Cost of Debt
 Pr. Shares
Cost of debt  Equity
 Retained earning
Cost of debt –
PV method
 It is also referred to as a “hurdle” rate because this is the minimum
acceptable rate of return
 Any investment which does not cover the firm’s cost of funds will
reduce shareholder wealth (just as if you borrowed money at 10%
to make an investment which earned 7% would reduce your
wealth)
  Capital structure-where? Why?
 Combination of equity: debt
 Cost of capital
 Min required return on project
 Cost of debt (Kd) – Interest
Revision  Cost of preference shares (Kp)-div
 Cost of equity shares (Ke)div
 Cost of retained earning (Kr)
  Cost of debt (Kd)
Components  Cost of preference shares (Kp)
of Cost of  Cost of equity shares (Ke)
Capital-WACC  Cost of retained earning (Kr)
(Ko)
Cost of Debt
  RS 100- 10% Rs 10 – 3 years
 33+10
 33+Int on 67
Revision  34+Int on 34
  Fixed interest rate= risk free rate +duration+ credit rating
 Issue expenses like underwriting commission, Brokerage-
Floatation cost
 Net sales proceed = issued price- Commission /floatation cost
Factors  Discount / premium on issue/ Par
effecting cost  Redemption
of debt  Corporate tax rate – Interest
 EBIT 100
 - Int 10
 EBT 90
  Interest- Rs 100-Interest rate 10% - Tx rate 30%
 Pre-tax cost -Rs 10
 Post tax cost Rs 7 (Rs 10-3)
Cost of debt
(Kd)
 Debt

Classification
of debt on the
basis of Redeemable Irredeemable
Debt Debt
redeemability

Redeemable
Redeemable
in
in lump sum
instalments
  A company issued Rs 100 lakhs 12% debentures of Rs 100 each
redeemable at par after 5 years. Calculate the cost of debt according
to present value method in each of the following cases (corporate
tax rate is 40%)
 Case 1: If debentures are issued at par with no floatation cost. (net
sales proceed- issued price- floatation cost) NSP= 100
Question: 1
 Case 2: If debentures are issued at par with 5% floatation cost. NSP=
95
 Case 3: If debentures are issued at 10% premium with 5% floatation
cost. 104.5
 Case 4: If debentures are issued at 10% discount with 5% floatation
cost. 85.5
  A company issued Rs 100 lakhs 12% debentures of Rs 100
each redeemable at par. Flotation cost is 10%. Corporate tax
rate is 40%. Calculate the cost of debt according to present
value method in each of the following cases: NSP=90
Question:  Case 1: If 20%(Rs 100*20%= Rs 20) debenture are
redeemable each year beginning with the end of year 1.
2(cost of debt  Case 2: If debentures are redeemable in 5 equated annual
redeemable in instalments beginning with the end of year 1.
Instalment)  Case 3: If debentures are redeemable in each year beginning
with the end of year 1 in the ratio of 1:1:2:3:3.
 Case 4: If 20% debenture are redeemable each year
beginning with the end of year 2.
Preference shares
  An amount paid by company as dividend to preference shareholder is
known as Cost of Preference Share Capital.
 Preference share is a small unit of a company’s capital which bears fixed
rate of dividend and holder of it gets dividend when company earn profit.
Dividend payable is not a tax deductible amount. So, there is no tax
Preference adjustments required for comparing with cost of debt.

shares
  Fixed dividend rate
Preference  Issued price
shares  Dividend tax
  A company issued Rs 100 lakhs 14% Preference shares of Rs 1000
each redeemable at par after 6 years. Calculate the cost of
preference shares using to present value method in each of the
following cases (F=Dividend tax rate is 20%)
 Case 1: If Preference shares are issued at par with no floatation
cost.
Questions 1  Case 2: If Preference shares are issued at par with 5% floatation
cost.
 Case 3: If Preference shares are issued at 10% premium with 5%
floatation cost.
 Case 4: If Preference shares are issued at 10% discount with 5%
floatation cost.
 https://www.indianivesh.in/market-commentary/tata-capital-pref
erence-shares-issue-2019

 https://www.tatacapital.com/content/dam/tata-capital/pdf/invest
ors-and-financial-reports/annual-reports/20-21/Tata%20Capital%
20Limited%20-%20Annual%20Report%20FY%202020-21.pdf